Importance of the chance in the equity market

Importance of the chance in the equity market

In my opinion, chance in equity investing is one of the most important concepts a successful investor needs to grasp. This is also one of the most important concept that even the seasoned professional seems to forget.

To give you an example, imagine an investor sets out reasoned argument for us why a particular stock should do well. After looking closely his analysis, we then follow the stock. Some months or years down the track we note that the stock had done exceptionally well, and all the investors in that stock are happy lads.

After this, it is our natural instinct at that time to think that the investor who set out the initial thesis is someone to be taken more seriously. I would go one step ahead and say, this investor has a good grip on what stocks do well and why. Someone who we should pay attention to when they next time pen down their opinion on any stock. Maybe this is the reason you all come back to our blog and read our writings.

In reality, what we can reliably conclude from the above example is nothing. Nil. The reason for this lies in the statistics of stock picking.

In the Valueoperations blog, for example, we are proud of our track record. In the last four years and ten months since inception, we had shared our investment framework that can give you extraordinary returns with lower risk and also our views on many stocks. However, we didn’t achieve that by getting everything right. Far from it. If you analyse our individual stock picks over the last few years, you will find that we got only 60% of them right.

That means from ten calls we were right only six times.

What that means is that if you take sample of one of the historical stock pick at random, the chance it will be a dud is 40%; not much different to coin toss. As a result, there will be no doubt, many people who have heard us shouting the merits or demerits of any stock in the past, only to see it go other way. Their natural thought process will conclude that this guy don’t know what he is doing.

The reality of successful investing, is about having that small statistical edge, is all about you can hope for. Market is full of smart people trying to find best investments, and not much gets past them. The good news is that if you apply that small edge consistently time and time again is enough to generate very good results. It won’t pay off every month or every year. However, if you keep applying that consistently to all the calls for a longer timeframe, statistics start to work in your favour, and that edge delivers good results.

So, beware of those great stories and their calls. Separating skills from luck requires a lot of data. If you do your own stock – picking, then apply your methodology consistently and ruthlessly, even if luck runs against you, as it will inevitably sometime.

So if anyone comes again to you with the idea of his/her stock pick, gauge the weight of the analysis and reasoning to determine whether it contains the critical statistical edge. Judging from single stock call is only marginally better than judging based on the flip of coin.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise to take professional advice before going ahead with our views.